Companies serving the cannabis market need to establish good policies and procedures.
Granting credit has not yet become standard in the cannabis market, but as discussed in my article “Trade Credit in Cannabis,” published in the May issue of mg, I believe it will be in the future. Therefore, it is important that a company create a credit policy to define how it will manage its credit and collection processes and evaluate credit risk. Once that is accomplished, the next, and most important, step is to develop a credit application.
Why do you need a credit application?
A credit application provides basic information about a customer’s business and offers measures of protection that will increase the ultimate collectability of an account if the customer doesn’t pay. Companies in the cannabis market may aid their collection efforts by requiring all customers, even those that are on cash terms, fill out a credit application. I cannot emphasize enough how many times my firm, AG Adjustments (AGA), has been successful in recovering a client’s past-due monies because the clients took a proactive approach and obtained a well-drawn-up credit application.
The credit application is one of the primary tools available for protecting a company and controlling credit risk when extending trade credit to customers. Remember, taking a check from a customer is a form of credit. Even customers who are paying cash on delivery should fill out a credit application.
What is a credit application?
A credit application is a contract between seller and buyer. A good credit application will benefit the seller; a bad one, the buyer. Therefore, it is important to be certain the credit application, whether electronic or on paper, contains all the safeguards and guarantees available to reduce risk.
Securing a credit application does not guarantee payment, but it is one of the more significant documents to assist in making good credit decisions and ultimately collecting past-due accounts receivable and associated collection fees. The adage “the sale is not complete until the money is in the bank” is as true today as ever. A good credit application will assist in getting money into the bank.
What do companies selling into the cannabis market need to know to control credit risk?
A credit application is the first step in gathering information about potential customers. Even if customers pay in cash, the day will come when that system changes, and getting information about accounts at the start of business relationship is key. The more you know about its debtors, the better. In addition, collecting credit information will make it easier to determine exactly how much credit to extend a customer.
Never assume all information on the application is correct. Verify the information provided before granting credit. The sales department must make sure every customer fills out and signs a credit application prior to delivery of any goods or services, even if the customer is paying C.O.D.
A credit application serves two purposes: It is a data-gathering tool and a contract. As a contract, it specifies the rights and obligations of both the customer and the creditor. The application should be written in a way that provides the creditor an advantage if a business relationship with the client falters. As the saying goes, “Credit is not a right but a privilege.”
The Most Important Things To Consider Are:
- The signer(s) must be to legally bind the company. If the signer is not authorized to accept the terms and conditions of the credit application, they can’t sign the application.
- If possible, make a personal guarantee part of the credit application. While many owners of cannabis business may be hesitant to sign a personal guarantee, AGA recommends company owners and their spouses sign personal guarantees before credit is extended. Many personal guarantees have no value, but it’s still better to have one than not. Requiring the social security number of any individual signing a personal guarantee is imperative so that if the contract must be enforced, the creditor has an easier time tracking them down a borrower in the event of non-payment or flight.
- Stipulate that the customer will pay interest on past-due amounts and pay any collection, legal fees, and court costs incurred because of non-payment. Failure to specify collection terms in a credit application leaves a creditor unable to collect fees if the debt is placed with a collection agency. In the event of litigation, it is up to the local court’s discretion whether collection fees, attorney fees, and interest will be awarded.
- Obtain assurance that only the disputed portion of a past-due amount may be withheld by the debtor.
- Filing non-payment lawsuit should be as convenient as possible. The choice of venue must be the creditor’s. While many creditors request suits be heard in the local jurisdiction, this is not necessarily in the creditor’s best interest. A customer’s assets normally are located physically near the creditor. Post-judgment remedies must be recorded in a debtor’s local jurisdiction to attach assets.
- The credit application must include authorization for the creditor to obtain information about the customer from credit bureaus, banks, and trade references before authorizing credit and after the applicant is a customer.
- Obtain current financial statements and permission to obtain future statements once the applicant becomes a customer.
- Specify the right to inform state licensing agencies of ongoing disputes.
Verifying the credit application
The first thing to do once an application is obtained is to get a commercial credit report from a leading credit bureau such as Dun & Bradstreet or Experian. Many prospective customers may not have a lengthy credit history, but that will change as the cannabis industry moves forward. Contact at least three trade-credit references, as well as the applicant’s bank, to verify the existence of accounts. Be sure all references are legitimate, or at least exist if one or more are difficult to contact. Any false information on the credit application is a strong indicator the potential customer may not be reliable. If the buyer is looking for a substantial credit line, review their financials, especially a statement of cash flow. If the applicant is operating in a negative cash position, ensure they will have enough cash available to pay their debt. Limit their credit line or, at the very least, modify payment terms if it seems an applicant may have a cash flow problem.
After credit is extended
Periodic credit reviews are a necessity. Account defaults arise with existing long-term customers as well as new ones. Customer credit limits should be reviewed periodically—at minimum, once a year. Obtaining current credit bureau reports about the largest customers annually is a good idea. Stay on top of aging accounts receivable. If a customer is always sixty to ninety days past-due on part of their balance, they are only one period away from becoming a problem.
When trade credit becomes the norm in the cannabis industry, asking a new customer to fill out a credit application will become standard practice. Currently, this is not the case in the cannabis industry; nevertheless, AGA recommends companies operating in the market implement sound credit policies and processes now in order to prepare for the near future.
SAM FENSTERSTOCK is SVP of Business Development at AG Adjustments, a provider of commercial collection services. Previously, Sam was Director of Business Development at PredictiveMetrics, a statistical-based credit and collection scoring and modeling company that he helped grow and sell to SunGard (FIS) in 2011. Sam can be reached at [email protected]